Date of this Version
Real Estate Economics
This article establishes a theoretical and empirical link between the use of aggressive mortgage lending instruments, such as interest-only, negative-amortization or subprime mortgages, and the underlying house prices. Such instruments, which come into existence through innovation or financial deregulation, allow more borrowing than otherwise would occur in previously affordability-constrained markets. Within the context of a model with an endogenous rent-buy decision, we demonstrate that the supply of aggressive lending instruments temporarily increases the asset prices in the underlying market because agents find it more attractive to own or because their borrowing constraint is relaxed, or both. This result implies that the availability of aggressive mortgage lending instruments magnifies the real estate cycle and the effects of fundamental demand shocks. We empirically confirm the predictions of the model using recent subprime origination experience. In particular, we find that regions that receive a high concentration of aggressive lending instruments experience larger price increases and subsequent declines than areas with low concentration of such instruments. This result holds in the presence of various controls and instrumental variables.
This is the peer reviewed version of the following article: Pavlov, A. and Wachter, S. (2011), Subprime Lending and Real Estate Prices. Real Estate Economics, 39: 1–17., which has been published in final form at doi: 10.1111/j.1540-6229.2010.00284.x. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving http://olabout.wiley.com/WileyCDA/Section/id-820227.html#terms.
Pavlov, A., & Wachter, S. M. (2011). Subprime Lending and Real Estate Prices. Real Estate Economics, 39 (1), 1-17. http://dx.doi.org/10.1111/j.1540-6229.2010.00284.x
Date Posted: 27 November 2017
This document has been peer reviewed.